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This article, Part 1 of 4 of an InSights series, demonstrates why the pay mix is often the key differentiator when it comes to recruitment and retention from the applicants’ perspective. The upcoming Part 2 analyses the effect pay mix may have on the firm’s financials, especially with regards to personnel costs.  In Part 3 we will examines how pay mix should be adjusted in relation to the total cash compensation offered and how benchmarked market percentiles are the most effective indicator of competitive positioning. And, in the final Part 4 we will assess how pay mix may influence firms’ culture and performance, we will examine how pay mix may influence firms’ culture and performance.

‍Pay Mix as the Key Differentiator

Synopsis: One aspect of remuneration strategy is the ratio of variable to fixed pay (also called “pay mix”). Together they often make up the total pay of consultants. Unfortunately, the importance of pay mix is often underestimated or even overlooked.

When pay packages of competing firms are considered to be largely similar, the pay mix can become the key differentiator when comparing compensation, especially from the applicants’ perspective. Thus, when reviewing remuneration, firms should not focus on a single component of compensation (e.g. fixed or variable pay) as these alone will often not be the deciding factors. Firms should instead focus on the pay mix, i.e. the ratio of variable to fixed pay, as this ratio strongly influences an applicants’ choice. Depending on the risk-profile of the applicant, a lower level of total pay with a higher absolute level of fixed pay may be the better offer for many risk-averse applicants; conversely a higher level of total pay with a significantly higher variable component in the pay mix may be more attractive to risk-friendly applicants.

For professional services firms in particular, employee compensation is crucial to both successful recruitment and retention, i.e. hiring the right employees, continually motivating them to perform at their best, and retaining employees. Thus, together with firm culture, the importance of offering a competitive compensation package cannot be overstated.

In this InSights article we will take an in-depth look at the pay mix (i.e. the ratio of variable to fixed pay) within total pay, an aspect of compensation package design often underestimated. However, we will demonstrate that it can be as relevant as or even more relevant than the absolute amount of total pay (e.g. total cash compensation), especially from the perspective of new applicants.

To illustrate our arguments, the following Base-Case example will be applied:

An applicant for an entry and/or more junior-level consulting position receives offers from two comparable companies with similar status in the market. The two firms also offer comparable future development prospects to the applicant. For simplicity, the offers of employment made by the two firms are essentially the same to all applicants with the only differentiating factor being the pay mix of the compensation package offered (Exhibit 1):

Exhibit 1: Original offers of two competing firms with different pay mix

Both of the competing compensation packages offered total to USD 100k and from an economic point of view the upside potential of the two firms’ offering is the same (at USD 100k). However, while Firm 2’s offer provides the same total pay, it also offers the higher fixed pay component, which guarantees greater annualised financial security (65k vs 60k). Since Firm 2’s offer also provides the higher intra-year fixed pay (+8%) it would be considered “safer”. It would thus seem reasonable to assume that applicants will prefer Firm 2’s offer.

Assuming furthermore that the compensation packages being offered are transparent to all applicants, the result of this example would likely be that Firm 2 is able to hire all of the applicants it requires. Only when all of Firm 2’s vacancies have been filled, would the remaining applicants be forced to take the offer from Firm 1. Thus, Firm 1 would only be able to hire the applicants not needed by Firm 2 and would lose the competition for talent.

How could Firm 1 adapt their compensation model in order to be more attractive to potential applicants and be in a position to compete with or better Firm 2’s offer in the war for talent? Three alternative options stand out for Firm 1:

·        Alternative 1: Changing the pay mix;

·        Alternative 2: Increasing total pay (with the same pay mix);

·        Alternative 3: Both of the above.

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Alternative 1 – Changing the pay mix

Increasing the fixed component of pay at the expense of variable pay will provide applicants an even safer offer without the need to change the total pay of USD 100k (Exhibit 2). In our example, Alternative 1 increases Firm 1’s fixed pay from USD 60k to 66k at the expense of the variable pay (reduced to USD 34k from 40k). From the applicant’s perspective, changing the pay mix as suggested in Alternative 1 now makes Firm 1’s offer even safer and thus more attractive than Firm 2’s offer. Thus, following the arguments used in the Base-Case, Firm 2 would now only be able to hire the applicants not needed by Firm 1 and would lose the competition for talent. 

Exhibit 2: Alternative 1 - Changing Firm 1’s Pay Mix

It is important to keep in mind, however, that this alternative also changes the financials for Firm 1: Firm 1 would now incur higher fixed costs due to the change in Firm 1’s pay mix, i.e. they now offer a higher fixed pay component in their total pay. The implications of such a change will be examined in Part 2 of this series.

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‍Alternative 2 – Increasing total pay (with the same pay mix)

The result of an increase in total pay by increasing the fixed pay component with the same pay mix is shown in Alternative 2. In this alternative Firm 1’s total pay is increased to 105k, while the pay mix remains the same with variable pay equal to 67% of fixed pay (Exhibit 3):

Exhibit 3: Alternative 2 – Increasing the Total Pay Offered by Firm 1 with same Pay Mix

Increasing Firm 1’s total pay offering to USD 105k whilst maintaining the ratio between variable and fixed pay may make Firm 1’s “Alternative 2” offer more attractive than Firm 2’s offer of USD 100k. However, whether applicants prefer this offer over that made by Firm 2 will depend in part on the risk profile of the applicant: The more risk-taking or self-confident applicants will probably prefer this alternative offer since they can potentially earn more although a greater portion of pay is at risk. Conversely, the more risk-averse applicants may still prefer Firm 2’s safer offer with a fixed pay of USD 65k versus the alternative of USD 63k offered by Firm 1.

Alternative 2 again has implications on the financials for Firm 1: Firm 1 would now have to manage both higher fixed costs due to the increase in fixed pay (USD 63k versus 60k), as well as potentially higher variable costs due to the increase in variable pay (USD 43k versus 40k).

Alternative 3 – Increasing total pay and changing the pay mix

When considering the possibility of changing both the pay mix and at the same time increasing total pay, a number of alternatives are possible. A representative sample of these are examined in Exhibit 4.

Exhibit 4: Alternatives 3a to 3b for Firm 1 by increasing Total Pay and adjusting Pay Mix

From the applicants’ perspective, Alternatives 3a to 3b are both better than Firm 1’s original offer in that they offer a higher total pay (USD 105k versus 100k). Alternatives 3a and 3b may also be better than the offer being made by Firm 2. However, here the situation should be further examined by considering the differentiated pay mix:

·        Although at USD 105k Firm 1’s Alternative 3a offers a higher total pay it remains riskier than Firm 2’s offer because at USD 60k the fixed pay portion is still lower than Firm 2’s offer of USD 65k. Hence, whether applicants prefer Firm 1’s Alternative 3a over that made by Firm 2 will again depend in part on the risk profile of the applicant. Some more risk-averse candidates may not be inclined to go for the higher total pay being offered by Firm 1’s Alternative 3a since in case of under or non-performance, the higher fixed pay offered by Firm 2 continues to be the safer harbour.

·        Firm 1’s Alternative 3b again offers a higher total pay (USD 105k) but also offers the higher fixed pay at USD 69k versus Firm’s USD 65k. It is thus per definition the safer offer. Alternative 3b furthermore offers the higher variable pay at USD 36k versus the USD 35k of Firm 2. In essence, this is a win-win situation for the applicant: Less risk, as well as higher upside potential. Independent of any applicant’s risk profile, it is the more attractive offer.

In practice we often observe that some applicants are not attracted by the marginally higher total pay packages that come with a riskier pay mix (i.e. higher percentage of variable pay). In addition, in some countries and with some firms, the targeted variable pay may not be considered realistically achievable. Thus, the only value that counts, especially from the perspective of the applicant, is fixed pay (i.e. the “bird in the hand” argument).

In this respect, the solution in an ideal world would be very simple: Companies offer applicants the highest fixed pay compared to all other “competitors for talent” (which can be market participants within the same industry, but also in other sectors) hoping to attract and to retain the best performing employees in the market. In the real world, however, the interests of other stakeholders, such as the firm’s owners often stand in the way: Owners (or stockholders) are interested in sustainable profits and above-average growth rates and are therefore generally only prepared to accept above-average pay for employees if these also perform exceptionally well. Or to put it another way: “In the world of consulting, there is no free lunch”.

We are at your disposal for further questions and suggestions regarding how you may optimise the design of your pay mix (and/or remuneration systems) at your company.

Andy Klose is an Associate Partner at Vencon Research International and leads the firm’s advisory service. Erwin Harbauer is Vencon Research International’s Managing Partner.

Vencon Research International is a leading provider of compensation benchmarking and research, as well as of compensation and performance-related consulting services for professional service companies, especially for audit and tax, management consulting, and IT services companies. Vencon Research International provides services to a full range of clients in more than 70 countries worldwide and is proud to name more than 85% of the world’s major consulting and/or professional services companies as its clients.

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By Gonzalo Lavín Alfaro - Business Development

Evaluating the "new normal"

Factors such as the COVID-19 pandemic, technological advancements, and evolving work dynamics have ushered in a new era of flexibility, leading to a rapid surge in remote work. This paradigm shift has not only redefined our work practices but has also presented several advantages for both employees and employers. However, it is crucial to retain a reserved approach to evaluating remote work while identifying the trends that have emerged since its widespread adoption and implications for human resources managers worldwide.

What was once considered unimaginable a few years ago is now commonly referred to as the "new normal", especially in sectors where office work predominates. And by now, we are all familiar with the benefits commonly associated with remote work, including:

1. Enhanced employee well-being: Reduced commute times translate into decreased stress levels, improved mental well-being, and lower transportation costs.

2. Optimal utilization of office space: Remote work diminishes the need for extensive office space, leading to cost savings for organizations.

3. Promoting sustainability: With no commuting involved, there is a reduction in vehicle usage and subsequent pollution.

Challenges and debates around remote work

Despite the well-publicized advantages, remote work also poses certain challenges. Potential drawbacks include isolation and reduced social interaction, which can impact mental health. Moreover, while arguments extolling the productivity gains of remote work abound, there are also serious voices that claim the exact opposite. While these are often dismissed as reactionary management positions, they deserve equal consideration.

The rise of remote work has also given rise to other challenges, particularly in relation to location flexibility. Some individuals now work remotely from different cities, regions, or even countries. In such cases, questions arise regarding fair compensation for those residing in lower-cost areas, as well as concerns related to insurance and taxation.

An evolving landscape: keeping abreast of developments is crucial

Over time, work-from-home policies have undergone further evolution. During and directly after the pandemic, the proportion of companies offering full-time remote work exceeded 90% in applicable sectors. However, more recently, some companies have begun reverting to traditional in-office work to address the aforementioned issues. According to Vencon Research surveys, it is common to see consulting companies offering employees 1 to 3 days of remote work, representing the majority of responses. While some firms in certain industries like IT and technology continue to offer 100% remote work, the overall trend has shifted towards a hybrid work model.

As firms worldwide continue to consider the efficiency and balance offered by different work models, remote work will remain an evolving and important aspect of human resources management. To further discuss our findings on trends in your industry or to seek our assistance in benchmarking your remote work policies, please don't hesitate to get in touch.

venconresearch.com/contact

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by Andy Klose, Associate Partner and Advisory Team Lead

In the dynamic consulting industry, performance metrics and compensation packages for C-Suite executives are invariably a central topic of discussion. Recent debate has raised concerns about the potential short-term focus of these metrics, which may hinder the long-term development of consulting firms.

This article provides an overview of current practices surrounding C-Suite Key Performance Indicators (KPIs) and compensation in the consulting industry, while also exploring the evolving notion of stakeholder engagement and the need for a balanced approach. The insights presented here are based on an anonymous survey conducted by Vencon Research International among leading consulting firms.

Aligning Goals for Long-Term Success

Consulting firms adopt diverse approaches to structuring their C-Suite positions. In our survey, fewer than expected firms reported a fully dedicated C-Suite, while many firms implemented structures where their C-Suite members are at least partially involved in project related or client-facing work. Most firms offer between 4 and 5 C-Suite positions, often following a functional breakdown that includes CEO, CFO, COO, CHRO, CTO, and CLO. This breakdown aligns with the traditional focus on key stakeholders such as clients, firms, owners/partners, and employees.

Balancing Short-Term and Long-Term Goals

A key concern highlighted by the survey is the potential short-term orientation of C-Suite performance metrics. While most firms maintain a focus on traditional stakeholder groups, only a few have formally incorporated broader societal and environmental goals. It is essential for consulting companies to strike a balance between short-term quantitative goals and long-term qualitative objectives. By doing so, they can achieve sustainable growth and promote the well-being of their stakeholders.

Setting Long-Term Goals

The majority of consulting firms have embraced longer-term goals for their C-Suite, typically spanning a 3-5 years horizon with annual milestones. These goals primarily revolve around achieving growth and improving profit margins. The use of compounding multi-year averages has been suggested as a means to encourage consistent performance and mitigate the impact of short-term fluctuations.

Tailoring Goals for Success

While aligning goals across the C-Suite is common practice at most firms, some firms intentionally differentiate goals for individual members. This approach fosters lively discussions and progress, allowing each function to be managed using the most appropriate and impactful metrics. However, effective cross-management by the CEO is vital in implementing this strategy.

Linking Performance to Compensation

In the consulting industry, the link between goal achievement and C-Suite compensation is strong, with a majority of firms implementing models that correlate the two. Also, most firms apply minimum thresholds that impact compensation, ensuring that executives meet certain performance criteria. However, the quite regular use of caps on variable pay has been debated, with alternative methods suggested to manage performance peaks.

Navigating Challenges

While most firms reported being well or fully aligned with their company's strategic goals, more than half acknowledged challenges in defining a long-term orientation and evaluating progress. To address these issues, Vencon recommends setting clear, measurable, and comparable goals that consider both past performance and future aspirations. Transparency and control in the evaluation process are critical in ensuring fair compensation and encouraging continued growth.

Conclusion

The consulting industry recognizes the importance of balancing short-term performance with long-term development. By implementing effective performance metrics and aligning goals with strategic plans, consulting firms can drive sustainable growth while promoting the well-being of their stakeholders. The deliberate differentiation of goals for C-Suite members and the use of compounding multi-year averages contribute to enhanced performance and discussions. As the industry evolves, a comprehensive and balanced approach to setting KPIs and compensating C-Suite executives will be crucial for long-term success.

We would be happy to assist your company in defining the compensation components for your company’s C-suite, as well as the dimensions and correlations that determine pay-out of compensation (e.g., bonus) based on target achievement. Please contact our Advisory Team for more information.

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Despite robust earnings in the consulting industry in 2022 and a mostly strong final quarter of 2022, consulting companies are either experiencing a slowdown after just two months into 2023 or have already started adjusting to an expected slowdown in the project pipeline for this year.

Due to the recent COVID-19 pandemic, the consulting industry has been able to reduce operational costs (e.g., less travel, etc). But what puts additional pressure on margins is that many consulting companies have increased salaries due to above average inflation rates around the globe while billing rates were not (or could not) be increased accordingly.

These factors have compelled consulting companies to re-examine their cost position, e.g. by re-examining their fixed costs, in particular evaluating the value brought by their non-client facing staff.

In the light of this, for industry insiders it is no surprise that e.g. McKinsey is announced cutting 2,000 non-client facing staff, KPMG is laying off up to 700 employees in the USA and 200 in Australia, and EY is planning to cut 400 staff in Germany.

The priorities of consulting companies are now – apart from trying to ensure their consultants remain highly utilised – being set to more strongly focusing on increasing profitability and competitiveness (instead of sheer growth).

For more information on how your competitors are responding or how you may successfully respond to these challenges, please contact Vencon Research – as always, we are happy to assist you.

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By Gonzalo Lavín Alfaro - Business Development Team

Belgium’s consulting industry is facing severe challenges as a result of the government's policy of annually adjusting wages based on the inflation index.

The Belgian government enacts a wage adjustment policy each January based on an index of inflation for a specific group of employees to ensure they maintain their purchasing power. However, this cost is passed on to firms, resulting in reduced profitability.

Up to now, consulting firms have been able to offset this cost increase with increased productivity. According to one client in the consulting industry, "when salary costs increase by less than 5%, a similar increase in productivity was normally achievable."

However, the required wage adjustment in January 2023 of 11.08% poses a steep challenge. While some firms have attempted to increase their rates and pass on the cost to clients, many clients are unwilling to accept higher rates and are instead requesting discounts or fewer charged days due to the current economic climate.

In response, firms are considering other measures to address these challenges. One idea is to adjust target bonuses, particularly for workers in higher seniority levels. This would help firms manage costs while maintaining competitiveness but still rewarding lower level employees for their performance.  Another more radical idea, albeit not uncommon in the Belgian market already, is to expand the usage of external contractors as consultants, allowing firms to avoid certain types of taxes and giving them more flexibility in managing their workforce. While this approach may have benefits for firms, it could also have implications for workers, such as reduced job security and fewer benefits.

Should you want to discuss the ideas being considered by your competitors or how you may successfully respond to these challenges, please contact Vencon Research – as always, we are happy to assist you.

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